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“Banking Shadow” now represents 250 billions of dollarsOr 49% of global financial assets, according to the Financial Stability Board. Healing funds manage 15 times more combined assets than in 2008. The recent bond yield peak – trained by hedge funds with transactions strongly with leverage – some people are worried about this largely unregulated company could constitute a 2008 -style threat to the financial system.
The economist Paul McCulley invented the term “ghost bank” in 2007, just over a year before the collapse of Lehman Brothers. Soon, it has become clear that easy credit had helped to feed the risk mortgage which has put the global financial system on its knees. Almost two decades later, a bond market sale launched by the deployment of President Donald Trump’s chaotic rate aroused fears of a similar liquidity crisis.
The great recession underlined how various institutions in addition to banks engage in loans without the same level of regulatory control applied to banks, even if they are also crucial to the health of the wider financial system. This time, however, the emphasis went from investment banks and mortgage creators to hedge funds and capital-investment companies. For example, an unusual peak in the yields of the American treasury, which increases as the price of bonds drops, highlighted the height of leveraging transactions helps maintain the monetary markets by humming – but could also constitute a wider threat for the economy when they disentangle.
Banks, of course, transform the deposits into cash from customers into long -term non -liquid assets such as mortgages and other types of loans to consumers and businesses. Parallel banking institutions do the same thing essentially, but by collecting and borrowing funds from investors instead of using consumption deposits.
Although the descriptor of the “ghost bank” may seem disaster, there is nothing wrong on this subject, said Amit Seru, professor of finance at the Stanford Graduate School of Business and principal researcher at the Hoover Institution of the University, a conservative reflection group. In fact, the displacement of risky loans outside traditional banks can improve the resilience of the financial system.
“This is often a point that is lost,” he said Fortune.
Healing funds can take much greater risks than banks because they increase the capital of investors who often agree to “lock” their money for an extended period, helping to isolate the company from short -term losses. As Seru noted, these investors often facilitate the discovery of prices on the markets for bonds and other titles.
An example is the so-called “basic exchange”, when hedge funds buy treasury bills and sell term contracts linked to these obligations to take advantage of tiny price differences between them. By benefiting from arbitration, these companies deal with a fundamental imbalance in the credit markets created because the common funds, pension funds, insurance companies and other asset managers have a high request for term contracts on the Treasury.
But hedge funds must take strongly to make the service in value, sometimes using up to 50 to 100 times the lever effect, so that the markets for a short -term debt can be hardly affected when the trade of $ 800 billion takes place.
“This creates training effects,” said Seru. “You must always worry about training effects.”
It is not because hedge funds are not funded by consumer deposits that the government may not be forced to intervene when things go south. A decade before the controversial barters of the bank in 2008, long -term capital management was also deemed “too large to fail”.
The activities of LTCM have focused on the realization of Paris with leverage on arbitration opportunities on the bond markets. He finally came to hold around 5% of fixed income assets in the world, but the company underwent unsustainable losses when Russia was lacking on its debt in 1998. To prevent a wider crisis, the US government orchestrated a rescue of 3.6 billion dollars – a massive sum at the time – banks of Wall Street which allowed the company to liquidate itself in order.
“The exhibitions we are dealing with now, I think, are much larger than that,” said Itay Goldstein, president of the finance department at the Wharton school of the University of Pennsylvania.
Ten years later, Lehman Brothers and Bear Stearns failed, threatening to bring a large part of the American banking system, as well as companies supported by the federal government like Fannie Mae and Freddie Mac, with them. None of the two investment banks has taken consumption deposits, but short -term debt markets nevertheless seized. Suddenly, as a large respect for the credit follows, the banks and the companies were hungry in capital.
In addition to the considerable increase in the regulations and monitoring of the largest banks in the country, the subsequent Dodd-Frank reform legislation also discussed non-banking lenders.
However, the shadow sector has exploded since the financial crisis. It now represents 250 billions of dollars, or 49% of global financial assets, according to the Financial Stability Board, more than double the growth rate of traditional banks in 2023. Hell funds, in particular, manage 15 times more combined assets than in 2008, in accordance Bloomberg.
The Volcker rule, which is part of Dodd-Frank, has prohibited investment banks for proprietary exchanges and, consequently, as market manufacturers by aggressively pursuing arbitration opportunities. The hedge funds intervened to fill the void. Their dependence on short -term debt and the relative lack of surveillance, however, poses concerns similar to 2008: they are now very important, and they can be “too big to fail”.
“If they explode, this will affect other parts of the financial system, including banks, then spread to the real economy,” said Goldstein.
In fact, loans to institutions such as hedge funds, investment capital and credit companies, and payment payment companies are the fastest part of the American banking system, noted Michael Green, portfolio director and chief strategist for Simplify Asset Management, an ETF supplier. Loans in the parallel banking sector exceeded $ 1.2 billion of dollars, according to weekly data from the Federal Reserve. Green, who founded a hedge -feded graze fund by George Soros and managed the personal capital of Peter Thiel, sees a clear risk of a 2008 style calamity.
“It is dramatically more likely,” he said, “as not being close.”
For example, with regard to basic trade, the periods of stress on the market can leave hedge funds vulnerable to margin calls and other pressures to liquidate their positions. However, when hedge funds discharge massive quantities of treasury bills, the market may have trouble absorbing them. The concerns concerning the risks of it can then spread references in the markets, a cornerstone of short -term loans, where American debt is the dominant form of guarantee.
This scenario took place at the start of the covid-19 pandemic, forcing the federal reserve to buy 1.6 billion of dollars of treasury bills over a few weeks. During the recent sale, economists and other market observers closely looked for the signs that the central bank should take place again. Over the past two years, the 10 greatest designer funds in America have more than doubled their borrowing at $ 1.43 Billion, according to the financial research office.
Some academics say that this arrangement is not ideal and have proposed that the Fed has set up a loan center for hedge funds to resolve these types of crises on the treasury market. But it is a much less realistic scenario if the Republicans of Congress convince the secretary of the Treasury Scott Bessent to reduce the government’s ability to designate major investment companies as systemic, or “too big to fail”.
There are persistent compromises in the regulation of these types of shadow banking institutions, said Seru. Treat them more as traditional banks and inhibits you the discovery of prices and the effective movement of funds, savers to users. But the threat of contagion is looming, even if companies are simply risking their own capital.
“You can’t have it in both directions,” said Seru.
In addition, the tightening of the screws on hedge funds will probably not help you if it allows another type of institution to intervene and to do the same thing essentially. After all, this is what happened when the hedge funds took advantage of the increase in the maintenance of investment banks.
“I don’t see how it makes the financial system safer,” said Goldstein.
While Seru is concerned about heavy surveillance, he said that regulators should focus on transparency on public and private markets. For example, if hedge funds take many risks, it is important to know if they are linked to lenders who are supported by the government, such as the Big Wall Street Banks.
If exposure to the broader system is important, he said, it is at this time that measures such that capital requirements should be applied to shadow banking institutions. But Seru warns a brewing crisis – even when it involves traditional and highly regulated lenders and is apparently obvious with hindsight – can be difficult to spot, citing the collapse of Silicon Valley Bank in 2023.
“We must be a little humble on what regulators can catch and what the markets can catch,” said Seru, “and realizes that there will be (there will be) problems in the two sectors.”
Especially when complex risks hide in the shadows.
This story was initially presented on Fortune.com
